For £160M, New Tax Changes Could Kill London’s Development And Investment Market

Buried deep in the documents the Government put out to explain its working in the Budget is a number: £160M (page 31).

That is how much it expects to raise per year once new regulations are in place that will charge overseas investors capital gains tax on real estate for the first time in 50 years.

An increase in the public purse would be helpful in times of sluggish economic growth. But the risk is that for £160M, Chancellor Philip Hammond has frozen the vital overseas investment in London’s residential development market needed to build new homes for the capital, and the commercial development required to support business growth. 

The changes to the tax regulations for overseas investors, which have been in place since 1965, may halt the commercial real estate market, which has continued apace in spite of the challenge from Brexit's political uncertainty. 

“Since the announcement I’ve spoken to investors from across the world and they’ve all said to me: ‘What is your government doing?’” JLL City of London head of capital markets Andrew Hawkins said. “‘Your government says it is open for business but it doesn’t seem to be in terms of the measures it is introducing.’ I think it is inevitable it damages some of the negotiations for deals that are ongoing at the moment and some people will be put off.”

The changes mean overseas investors will pay 20% capital gains tax on any uplift in valuation on property assets that happens after April 2019. So if the value of a property goes up by £1M after that date, an overseas investor now pays £200K of tax for which they were not previously liable.

There is the possibility that institutional investors would be exempt from these rules, but as of yet there is no clarity on what constitutes an institutional investor. Previously the British Property Federation has successfully lobbied government for exemptions to some taxes for institutions, and in those cases the definition covered “widely held” companies that have multiple investors, like listed companies or pension funds.

There is also no clarity on how gains after April 2019 will be measured. Will the entire property market be revalued at this point to measure any uplift that happens after this date?

Many of the major developments in London since the financial crisis have been undertaken by large overseas investors.

The redevelopment of the Olympic Park was by a consortium where the largest investor was Qatari Diar working with Australian company Lendlease.

The Malaysian owners of the Battersea Power Station redevelopment have faced significant criticism due to the lack of affordable housing at the scheme, but no British companies were among the final bidders for a scheme that will require more than £5B of investment and see a new Tube line built.

In the world of offices, Canadian investors Brookfield and Oxford Properties have been the most significant developers creating the new office space London needs to compete globally.

“A lot of the regeneration and development of London wouldn’t have happened without overseas investors in recent years and you have to be careful we don’t jeopardise that,” said Ion Fletcher, director of finance policy at the BPF. “Investors are already wary of the U.K. and this is another reason to say no.”

Fletcher said stymieing development also risks reducing the tax take in other areas and suppressing job creation. If fewer people are building they are not employing people in the construction sector and thus these people are not paying income tax or national insurance.

If it subdues investment volumes by reducing the incentive to trade then stamp duty land tax will fall.

The commercial investment market is not as vital to the public good as the development sector, but it will also be hit by the changes. The appeal of London on an international basis will change, with the potential return on investments reduced because 20% of profit is now eroded.

Some other countries have this rule, some do not. But it is notable that, for example, the U.S. is looking to reduce tax for overseas property investors to encourage more inward investment.

And the stats indicate overseas investors are vital to the London investment market. Colliers International estimates around 75% of London investment purchases are undertaken by overseas investors at the moment. Hawkins said that for deals of £100M or above, this figure rises to 90%.

Even if institutional investors are exempt, wealthy individuals are playing a huge part in the investment market and could be deterred — for instance, the £1.3B purchase of the Walkie Talkie by Lee Kim See Group earlier this year was a purchase made by a single wealthy family that would be unlikely to qualify for the tax exemption.

“It’s oxymoronic," Hawkins said. “We already have the highest property taxes of any developed country, according to the Organisation for Economic Co-operation and Development. We are saying we are opening up to global trade yet removing a reason for global money to come into infrastructure and housing.

“It will put some people off investing currently until there is more certainty, others will try and renegotiate current deals. The worst-case scenario is that money permanently goes to other, more transparent, countries.”

One possible unintended consequence is a huge glut of sales at the beginning of 2019 to try to avoid paying the new tax.

And of course another possibility is that nothing changes at all. The government did not outline how it thinks the change will influence the behaviour of investors. But given the constantly cited draw of investing and developing in London — friendly legal system, the English language, strong economic growth — the city could still retain its appeal.

“Modern international investors looking to buy or sell assets in the U.K. would simply consider the CGT as one more cost to factor into the their equations, which they already do in many other countries. So while we may see them scrutinize the price more closely, the appetite for U.K. assets is nonetheless likely to remain,” Colliers International Chief Economist Walter Boettcher said.

Still, it is a big risk to take for £160M a year.